Buffett: Wells Fargo made a mistake that dwarfs all others

At the Berkshire Hathaway (BRK-A, BRK-B) annual shareholders meeting, CEO Warren Buffett spoke more about Wells Fargo (WFC) and its 2016 scandal, in which up to 2 million credit card and bank accounts were created without customers’ permission.

“At Wells Fargo, there were three very significant mistakes, but there was one that dwarfs all the others,” said Buffett. “At some point if there’s major problem, the CEO gets wind of it. And the CEO has to act.”

According to Buffett, the Wells Fargo scandal evoked the Salomon Brothers incident, where the CEO underestimated a “flim-flamming” scandal involving treasury bonds as a “traffic ticket.” In reality, it was more of a ticking time bomb. This failure to address and solve the problem was far worse than setting up the system for incentives that would inevitably cause bad behavior. And in the case of Wells Fargo, the activities had gone on for years and resulted in the termination of 5,300 employees, something a CEO would notice.

The third mistake shines light on the second big mistake, in Buffett’s view, and it’s one of hubris—Wells Fargo’s “traffic ticket” response.

“They totally underestimated the impact,” said Buffett. “People get fined billions in the industry, so they measured the seriousness of the problem by the dimension of the fine and they thought $185 million [was small]. They were totally wrong on that.”

The news broke last September, but Buffett, whose company owns just under 10% of Wells Fargo, maintained a relatively low profile when discussing the San Francisco-based bank. In an interview with CNNMoney, Buffett said the quiet response came from his promise to regulators to be a passive investor in the company.

Still, the famous long-termist did take a measured look at the scandal, and has only sold the bank’s stock of late so that Berkshire could get below 10% ownership, the threshold that would turn Berkshire into a bank holding company.

How does Berkshire handle whistle-blowing?

The question that sparked Buffett’s comments, which retired Fortune editor Carol Loomis asked, came from a reader who noted that the Wells Fargo investigation had found the decentralized structure of the bank had been a factor in the scandal—something the shareholder saw in Berkshire’s own model.

“It’s true that we at Berkshire certainly operate on a decentralized plan,” Buffett admitted. Instead of rules, however, Buffett added, “We count very heavily on principles of behavior.”

Along with this, however, Buffett noted the Berkshire Hathaway’s hotline.

“At Berkshire the main source of information about anything being done wrong is the hot line. We get 4,000 hot line reports a year and most of them are frivolous, but there are a few serious ones and the head of our internal audit looks at all those,” said Buffett. “Anything that looks serious I will hear about. And that has led to action, more than once, and we’ve spent real money investigating some of these.”

“It has uncovered certain practices that we would not at all condone. I think it’s a good system. I’m sure they have an internal audit and hotline at Wells Fargo.”

At the bank, there was a hotline, and there were reports of retaliation for people who tried to blow the whistle. In the independent investigation of Wells Fargo, there was scant reference to whistleblowers and retaliation, something that has been criticized.

“I’m sure they have an internal audit and hotline at Wells Fargo. I don’t know the facts but I would have to bet a lot of communications came in on that. I don’t know who did what, but it was a huge huge error if they were getting—and I’m sure they were—communications and ignored them or sent them down.”

Still, Buffett is optimistic that the hotline is the best way to do things, when done correctly.

“Frankly I don’t see any better system than hotlines and anonymous letters. And I’ve gotten about three or four of them in the past years that have resulted in major changes. There will be no retribution obviously if they call our attention,” said Buffett.

“As we sit here, quite a few people are doing something wrong at Berkshire, but when it gets to some sales practice like was taking place at Wells Fargo, you can see the kind of damage it will do.”